E-lending companies feel rate hike burn

ColleenBazdarich

NEW YORK (CBSMW) -- Everyone has been complaining about rate hikes lately, but few companies are as directly linked to the Fed's decisions as the mortgage lenders.

"Over time, technology will improve to the point where you can complete a mortgage over the Internet. But the business is still very much correlated to interest rates."

Vincent Daniel, CIBC World Markets

Especially hard hit have been the burgeoning online mortgage players, who depend on a growing customer base to keep the business model afloat.

Things aren't looking great, but Vincent Daniel of CIBC World Markets says there are still some strong long-term plays in this sector. He believes that within the next decade, e-lending will make up more than 25 percent of the mortgage lending market.

That said, Daniel's long-term "buys" are in companies that speed up and minimize the costs of originating a loan.

CBSMW:E-lending is a fairly new sector, with all of the three big companies having gone public in the last year. How are they doing right now?

Daniel: Right now the mortgage market is really tough. Greenspan is raising rates; people expect he is going to raise them at least once more. This does not bode well for the mortgage market. That being said, mortgage volume, which is really the main driver for these companies, along with how much money they make on the loan originated, is getting tougher. If interest rates are rising then mortgage (volume) rates are declining. It's a tough environment, regardless of whether you are an Internet company or not.

CBSMW:People aren't locking in now because they are afraid of rates going up even higher?

Daniel: Well, mortgage volume has not necessarily fallen off a cliff, but it is well below the highs that we saw back in 1998 when interest rates were screamingly low.

CBSMW:Right, but those mortgage volume levels were at pretty strong highs, too.

Daniel: They were tremendous highs.

CBSMW:So the lending rate is down.... Is the drop in lending compared with the rise in interest rates following suit for how things have gone in the past?

Daniel: It is pretty much going to script. I think the last time we saw mortgage volume as high as we did in '98 was in '92 and '93. Then, when Greenspan raised rates, mortgage volume fell pretty strongly -- by about 24 percent. And then in '95 it fell again by 15 percent. I am expecting a similar type of percentage decline year over year for 2000.

CBSMW:In terms of the e-lenders, although mortgage volume is declining, is the percentage of those borrowers who use electronic lending going up?

Daniel: The amount of loans being done electronically is going up, but let me give you a little bit more than that. I'll use Amazon as an example.

With Amazon, you click your mouse, you buy a book. In two days the book comes to you.With a mortgage, you click to get your mortgage done and that's the beginning of the process. The majority of the process is still done offline. Therefore, a lot of these companies offer the front end, the beginning stages of the process. For reasons of technology and inertia from the political environment, you cannot complete a mortgage over the Internet fully, in its entirety.

CBSMW:There are companies that are trying to change that.

Daniel: Every company I know is trying to change that. The problem is that there is a political hassle -- electronic signatures are tough. All that being said, we 're not at the point of what I call "e-fusion," where you can just click through the whole process. There's that, plus the relationship between interest rates and mortgage volume is never going away.

Here is how I look at it: Over time, technology will improve to the point where you can complete a mortgage over the Internet, but the business is still very much correlated to interest rates.

CBSMW:So what is your long-term outlook for these stocks, then? You can't really predict interest rates.

Daniel: If I knew where interest rates were going to go, I would be a very wealthy man. But I will just say that Greenspan has said emphatically that he is going to raise rates to slow down the economy. That does not bode well for the mortgage environment.

So for the short term, these guys are deemed as Internet companies, yet they're very cyclical, with declining mortgage volume. That is not supposed to be the behavior of an Internet company, and the investment community has taken notice.

The nirvana of what the Internet is supposed to bring to the table -- think B2B, etc. -- is to make the process more efficient for the consumer, which e-lending has done. But the other thing that it is supposed to do is lower the cost of processing loans, which it has not done. In fact it has done the exact opposite. The mortgage business is a thin-margin business to begin with, a volume game. You don't make that much money when you originate and sell a mortgage. These guys lose money with every loan they originate given the current interest rate environment.

CBSMW:Is there a way to cut costs?

Daniel: Scale. As you increase your scale, hopefully those costs will come down.

CBSMW:Well, you don't have that right now.

Daniel: Exactly. These guys are not a generator of excess capital. They use capital, so they need to come back to the capital market. Their stock price is extremely important to them. You need the high stock price to attract capital, to get more money. If you look at the charts of Mortgage.com
mdcm, +0.00%
E-loan
EELN
and even Lending Tree
TREE, +0.71%
they are way down.

CBSMW:So, it doesn't sound very good. Do you have any "buys"?

Daniel: I have one "buy" on IndyMac
NDE
My theory is that no one has been concentrating on lowering the cost to process loans and taking that low-cost process to businesses like banks and offering to process their loans for a fee. IndyMac, which a lot of people do not know about, has the best technology in the business as well as the lowest cost. Therefore, in the this rate environment I don't expect short-term appreciation in the company, but this is a long-term winner.

CBSMW:How aboutCountrywide? You cover them.

Daniel: They do online lending too. The barriers to set up a Web site to do online lending is almost zero. The key is originating the loan quick and at a low cost. With Countrywide
CCR, +0.34%
I don't see any near-term appreciation, but no one is better at the game of origination quickly and cheaply than IndyMac and Countrywide. These guys have not been beaten by the e-lenders. I have a "buy" on Countrywide, but I don't see the stock going up in the short term. I think they are a long-term winners.

CBSMW:You do have some long-term "buys" then. It's not all dire.

Daniel: Right. For the long-term investor, be patient. If you have a long-term view, it is worth buying into IndyMac and Countrywide.

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